Denel in 2019 – new board, same old problems

Denel continued to struggle under the weight of liquidity problems, difficulty paying creditors, and a lack of skills and proper accounting systems according to the financial year ended March 2019.

To exacerbate its woes, state capture has left a climate of fear and mistrust in the organisation.

The Auditor-General (AG) was unable to obtain sufficient appropriate audit evidence to provide a basis for an opinion on the annual financial statements, and hence issued a disclaimer of opinion. This essentially makes all the figures reflected in the annual report suspect.

Lack of internal control and accounting records

Accounting standards specified by International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS) were not properly applied as, in addition to technical knowledge, these require effective internal controls, proper accounting records, and appropriate audit evidence.

A sample of the most critical transgressions are disclosed below:

• Revenue was not properly recognised. This resulted in an audit disclaimer on revenue, cost of sales, inventories, trade and other receivables, contract asset and liabilities, advance payments received, and provisions.
• The useful lives and residual values of property, plant and equipment were not adequately reviewed.
• The financial instruments statement was not properly applied, putting a question mark behind the reported figures for trade, other receivables and contract assets.
• The audit disclaimer also includes the reported figures for impairment of assets, investments in subsidiaries in the company, and investments in associates in the group.

Key financial figures

In a nutshell – revenue dropped to R3.8 billion (2018: R5.8 billion), cash dropped to R540 million (R1.3 billion), and borrowings are R3.4 billion (2018: R3.3 billion). Irregular expenditure (inadequate records) amounted to R2.1 million (2018: R1.9 million) and fruitless and wasteful expenditure came to R136 million (2018: nil).

Material uncertainty relating to going concern status

The group suffered a net loss of R1.7 billion (2018: net loss of R1 billion), increasing the retained loss to R7.8 billion (2018: R5.6 billion).

The group suffered a net cash outflow of R1.2 billion from operating activities, and had difficulty in paying its overdue core creditors.

On the bright side:

• Denel raised R1.4 billion in the investor market in September 2019, and received a further R1.8 billion from the government. The government will consider the R1 billion additional request in the medium term budget process, but Denel anticipates that these additional funds will be received in the first quarter of the 2020/21 financial year (that is, April to June 2020).
• Denel has major contracts worth R18 billion in its order book, which covers roughly four years of sales revenue, and a further R30 billion in the pipeline. Denel, however, does not specify the expected return and net cash flow that will result from these contracts.
• The government guarantees have been extended to five years. A further guarantee of R1 billion was extended to Denel in April 2019.
• The group will continue to reduce costs, and exit onerous contracts.
• There is potential to generate cash through the divestment of non-core assets to the value of R1.56 billion. A further R2 billion in cash is expected to be generated from strategic equity partnership activities.
• Denel has received expressions of interest from some 40 international and local defence and technology companies with regards to partnering with it or acquiring parts of the business.

Constructive action

• Denel is currently conducting a skills audit to match its current skills to its future technical skills requirements.
• There is active intervention to deal with the existing climate of fear and mistrust.
• Disciplinary processes have been introduced to address failures of governance. The group will follow through by means of criminal and civil litigation to act against corrupt individuals and recover money that was squandered.
• The group is committed to recouping and clawing back the financial losses that took place over a period of time in regard to irregular, fruitless and wasteful expenditure
• Voluntary severance packages have been offered to employees as part of the turnaround plan.
• Denel has acknowledged the root causes identified by the AG that resulted in the disclaimer of audit opinion, and has already taken action, such as improving documentation, ongoing training of staff, and identifying competent staff in finance with the relevant experience and expertise.
• A confidential whistleblowing hotline has been made accessible to all stakeholders, through which suspected fraudulent and unethical behaviour may be reported.

The board of directors, appointed in May 2018, is confident that Denel “has core products, basic systems and skills which form the critical and required base for an effective business turnaround”.

I’ve heard that song before.

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